What are the advantages of Incorporating my business?
Many businesses start out as a sole proprietorship - just one person and a great idea. Running your own business is a significant accomplishment with many satisfying aspects such as being in control of your workday, making all of the business and creative decisions and of course, the personal satisfaction of success.
When and why should one transition from a sole proprietorship to an incorporation? is a question every business owner should ask. The advantages of incorporation are:
Limited Liability - Protect Personal Assets
Name / Brand Protection
Credibility
Tax Advantages -
Canadian Small Business Tax Deduction
Income Splitting
Income Deferral and Capital Accumulation
Growth – Business Expansion
Unlimited Life – Immortality
Sale of the Business
Limited Liability - Protect Personal Assets
This is undoubtedly the greatest advantage of incorporating. When you incorporate the corporation becomes its own legal person, with all the rights and obligations of any other legal person. Being incorporated protects the business owner from being personally responsible for debts and liabilities, such as loan defaults, lawsuits and product malfunction. Whereas in a sole proprietorship the owner is the same legal person as the business, and the owner assumes personal responsibility of all the obligations of the business. Personal assets such as your house, car, investment account, etc. can be seized when you are a sole proprietor, whereas you will not be held personally responsible for debts of your corporation, the exception being if you have provided a personal guarantee (which many banks do require).
Limited liability means that the financial losses are limited to the amount invested in the corporation, to the corporation’s accumulated assets. There are a few exceptions to limited liability, these are in place through specific laws in place to protect certain creditors, such as government agencies and employees. In certain circumstances the shareholder can be personally liable for specific debts and liabilities. There are also specific laws in place that may make a director personally liable for certain debts. Thus, limited liability protection may be placed in jeopardy through certain actions or inactions taken by the shareholders and directors.
Name / Brand Protection
Incorporating a new business protects the business name, brand recognition and any trademarks associated with it. Incorporating under a specific named corporation provides protection against others using an identical or nearly identical name for their business or corporation. This protection is limited to the jurisdiction in which your corporation is registered. Incorporation of a business name doesn't provide as much protection as a registered trademark. If you have a Trademark associated with your name that you believe is necessary to protect, you could do so yourself or through a Trademark Agent. Although the Trademark process can be expensive, it provides wide ranging protection for your brand.
As a sole proprietor, or as a numbered corporation, you may have registered a Trade Name. This provides some protection against other Trade Names, but it is the least amount of protection for your business name. Anyone can come later and incorporate under that name which trumps your rights to continue to use that name.
When you incorporate your business provincially, the name protection is only for that province, or if you register extra-provincially, it becomes protected in those specific provinces. If you feel you need federal or international protection, you should consider a federal incorporation.
Credibility
A business that has been incorporated is typically perceived as more stable by customers, suppliers, lenders and other businesses. It sends a message that you are serious, committed and you are planning for the long-term. The result may be sustainable growth and longevity of operations. When you need cash injection for growth, the stronger your company image is, the more attractive it is to investors and lenders. You may also find lower rates for borrowing than if you’re a sole proprietor.
Further, using a corporate name can also make it easier to establish your brand name. If you are a contractor, you may find that some companies will only do contract to businesses who are incorporated companies for several reasons, such as liability issues and it sets clear boundaries of the nature of the relationship.
Tax Advantages
There are tax advantages to having an incorporated business compared to a sole proprietorship. A corporation is a separate tax entity with its own income tax rates. The net revenue from a sole proprietorship is taxed at your highest personal rate for that year, you cannot defer income to later years, and you have less flexibility to tax plan. A corporation’s net revenue is taxed at a much lower rate, plus you have more tax tools at your disposal to utilize. The availability of any potential tax benefits depends on your specific situation. If you would like advice with respect to whether any of the above benefits may apply to you, please speak with your tax or accounting advisor.
Corporations may make use of the lifetime capital gains exemption on the sale of the business. Additionally, corporations can deduct such things as health insurance, business losses, investments and travel expenses from their taxes.
All businesses located and operational in Alberta are taxed under the Alberta Corporate Tax Act. The province of Alberta currently asserts the lowest amount of taxation in the country, offering businesses lower rates of income tax and exemption from capital, general sales and payroll taxes. Incorporating provincially in Alberta can allow businesses to optimize their tax situation.
Canadian Small Business Tax Deduction
In Canada, you may qualify for the Federal Small Business Deduction (SBD), which could result in your net corporate business tax being reduced to a much lower tax rate than what is applied to your personal income. An incorporated business can claim a small business deduction, which is a reduction of the tax rate on the first $500 000 annual taxable income.
Income Splitting
When your corporation is set up correctly and has the proper share structure in place, a corporation has greater flexibility to compensate shareholders. Corporations have flexibility in how they pay their shareholders resulting in more options for tax planning. A Corporation can choose to pay a salary or dividends or a combination of both to compensate shareholders. Dividends are taxed at a lower rate than salary. You also have options to make family members shareholders who don’t have to be actively involved in the company. This allows the business owner the chance to redistribute income from family members in higher tax brackets to family with lower incomes who are consequently taxed at a lower rate. Although, recent changes to the Income Tax Act have reduced the effectiveness of income splitting for some shareholders and corporations.
Income Deferral and Capital Accumulation
Incorporated businesses can also take advantage of tax deferrals. When your business is successful and making more revenues than you currently need to take out, you can leave the earnings in the corporation as retained earnings, and take it out when you retire. This means you pay less tax on that income as your tax bracket will be lower. You can also set up retirement accounts for employees.
Growth – Business Expansion
Corporations have more options when needing capital for expansion, and easier access to financing, which may make it easier for your business to grow and develop. Lenders will often give corporations lower rates for loans. Additionally, corporations may find it easier to get equity financing from angel investors or venture capitalists.
You can register your corporation in other jurisdictions or federally if your company is growing. Franchising is another option for growth.
Unlimited Life - Immortality
Corporations are an enduring business structure. A business operated as a sole proprietorship automatically dissolves when the proprietor passes away. In contrast, an incorporated business has a virtually infinite lifespan. If shareholders pass away, their shares are passed on to their beneficiaries or otherwise transferred to new shareholders. The new owners will be able to continue the business of the corporation as though no changes have occurred, with the name, brand, product, etc. all protected. Having an enduring business structure also means that you can create long-term plans for growth.
Succession planning to pass the corporation down to family members or key employees is a vital aspect of your corporate plan and should be reviewed every three to five years.
Sale of the Business
If you are looking to eventually selling your business, an incorporated business is generally more attractive to buyers than a sole proprietorship. You have the flexibility to sell the shares or the assets. From an investor’s point-of-view, it is easier to track and manage a corporation. All of the corporation's contracts, licenses, receivables, etc. will remain in place. This can save considerable time and expense if the business is transferred. As well, because the business’s brand and image are protected by being incorporated, buyers will be more willing to purchase an already established and credible business instead of one that is not protected.
Corporation ownership is easily transferable because no personal assets are attached to the company. This is beneficial if you wish to transfer the company to a family member or new owner.
At Lozinsky Flett, we are here to assist you by taking care of your corporate legal matters and to make sure you are prepared to grow your business and prosper from start-up to wind-up.